We are all looking to save money on our major purchases. When we buy a house, we negotiate. When we buy a car, we take it as a source of pride when we can get the sales person to knock a couple of hundred dollars off of the purchase price. This type of negotiation is important if you want to save money in the long run.
But one area that many people ignore is what they are paying for their interest rates for credit they are extended. Most car companies are still offering zero interest on their car loans. Mortgage companies are advertising rates below 4.0% on a 30 year fixed rate mortgage. But to access those rates, you have to be what all of the commercials say is a “well-qualified buyer”. But we all fall into that category, right?
Not quite. As a matter of fact, very few people fall into the category of a “well-qualified buyer”. Fair Isaac — the company who created the standardized three digit credit score – has recently published their analysis of credit scores for the 200 million Americans who have enough information in their credit reports to generate scores. Here is the table.
Remember the current financial crisis and decrease in home values started in 2008. When everything was fantastic in 2005, 54.4% of Americans had a score of 700 or higher, which would have put those comsumers in the range of “well-qualified buyer”. Since the contraction of the credit market, only 53.2% of Americans are in that same range. That means 2.4 million people have allowed their credit scores to fall outside of that range. That represents a substantial number. The good news is that the lowest cateogry — 300-499 — has also decreased since 2005. More of us have slid into the middle categories, which means additional people have access to credit.
The difference between a 620 and a 720 credit score is huge when we are talking the ability to get the best interest rates. Most lenders have increased their minimum required credit scores to qualify for a mortgage. While credit scores are flawed in the eyes of some and do not provide the entire picture of your credit worthiness, they are the standardized method by which a lender will make a decision on extending you a loan. While we may not like the height of the wall in left field, it is the ball park we all have to play in. We might as well decide to make improvements in our credit scores to have access to the lowest rates.
The funny thing about credit — or FICO — scores is nobody really knows how they are calculated. There are three credit bureaus that report credit scores. Experian, Equifax, and TransUnion all use different formulas to calculated what your scores are. As a result, for more people, each of the three bureaus will have a different credit score for you because of the differences in their formulas. What are their individual formulas? Nobody really knows. Those formulas are kept secret. I think this is why so many people get frustrated with their credit scores — it is difficult to guess how much of an impact certain actions will have on your scores. Mortgage companies will take the middle of the three scores to use for qualifying purposes. Apply with a spouse? They will take the lower of the scores for the two applicants.
How does a low FICO score hurt your mortgage rate? Let’s say your FICO score is a 620. The company that is extending you a loan — think Bank of America, Wells Fargo, Quicken Loans — views you as a higher risk than someone who has a 720 FICO score. So, to compensate for that risk they will have what is called a “rate hit” for you. That can be anywhere from a .125 to .750% increase in your rate. So if you can qualify for a loan with your debt-to-income ratios but your FICO scores are low, then you will end up paying more on your interest rate.
The impact of a higher interest rate can be devastating. Let’s use my favorite example of a $200,000 fixed-rate mortgage with a 30 year term. Let’s say you are able to procure an awesome rate of 4.0% because you have been very careful with your credit and as a result, your FICO score is 740+. Your monthly payment for principle and interest will be $954.83. Now let’s compare that to someone who has a lower FICO score and has a couple of rate hits because they have not been taking care of their credit. Let’s assume their interest rate is 5.0% — their monthly payment will be $1,073.64 just because of the difference in their credit score. That is a difference of $118.81 in their monthly payment. Can you see how important taking care of your credit scores is? If you want to save money on the interest rates you pay, improve your credit scores. Credit card, mortgage, and other loan types interest rate is always dependent on your credit score. Some insurance companies are even using your credit score for insurance premiums.
In later posts we will discuss “What Makes Up My Credit Score?” and “How to Improve Your Credit Score”. The reality is at some point in our lives most of us will need to make improvements in our credit scores to secure the best interest rates. It is important to shop utah mortgage companies for the best rate, but help yourself by taking care of your credit scores. This advice goes to those of you in are looking for VA and FHA loans as well.